UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended March 31, 2008

or

SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number 1-16411

 

NORTHROP GRUMMAN CORPORATION

(Exact name of registrant as specified in its charter)

 

 

1840 Century Park East, Los Angeles, California 90067

www.northropgrumman.com

(Address of principal executive offices and internet site)

 

(310) 553-6262

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

As of April 22, 2008, 342,057,191 shares of common stock were outstanding.

 

 

NORTHROP GRUMMAN CORPORATION

 

TABLE OF CONTENTS

 

NORTHROP GRUMMAN CORPORATION

 

 

 

The accompanying notes are an integral part of these consolidated condensed financial statements.

 

NORTHROP GRUMMAN CORPORATION

 

 

 

The accompanying notes are an integral part of these consolidated condensed financial statements.

 

NORTHROP GRUMMAN CORPORATION

 

 

 

The accompanying notes are an integral part of these consolidated condensed financial statements.

 

NORTHROP GRUMMAN CORPORATION

 

 

 

NORTHROP GRUMMAN CORPORATION

 

 

The accompanying notes are an integral part of these consolidated condensed financial statements.

 

NORTHROP GRUMMAN CORPORATION

 

 

 

The accompanying notes are an integral part of these consolidated condensed financial statements.

 

NORTHROP GRUMMAN CORPORATION

 

 

 

Principles of Consolidation – The unaudited consolidated condensed financial statements include the accounts of Northrop Grumman Corporation and its subsidiaries (the company). All material intercompany accounts, transactions, and profits are eliminated in consolidation.

 

The accompanying unaudited consolidated condensed financial statements of the company have been prepared by management in accordance with the instructions to Form 10-Q of the Securities and Exchange Commission. These statements include all adjustments considered necessary by management to present a fair statement of the consolidated financial position, results of operations, and cash flows. The results reported in these financial statements should not be regarded as necessarily indicative of results that may be expected for the entire year. These financial statements should be read in conjunction with the audited Consolidated Financial Statements, including the notes thereto contained in the company’s 2007 Annual Report on Form 10-K.

 

The quarterly information is labeled using a calendar convention; that is, first quarter is consistently labeled as ending on March 31, second quarter as ending on June 30, and third quarter as ending on September 30. It is management’s long-standing practice to establish actual interim closing dates using a “fiscal” calendar, which requires the businesses to close their books on the Friday nearest these quarter-end dates in order to normalize the potentially disruptive effects of quarterly closings on business processes. The effects of this practice only exist within a reporting year.

 

Accounting Estimates – The company’s financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). The preparation of the financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingencies at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period. Estimates have been prepared on the basis of the most current and best available information and actual results could differ materially from those estimates.

 

Accumulated Other Comprehensive Loss – The components of accumulated other comprehensive loss are as follows:

 

 

Financial Statement Reclassifications – Certain amounts in the prior period financial statements and related notes have been reclassified to conform to the 2008 presentation, due to the disposition of certain businesses (Note 5).

 

 

Adoption of New Accounting Standards
The disclosure requirements of Statement of Financial Accounting Standards (SFAS) No. 157 – Fair Value Measurements, which took effect on January 1, 2008, are presented in Note 3. On January 1, 2009, the company will implement the previously-deferred provisions of SFAS No. 157 for nonfinancial assets and liabilities recorded at fair value as required. Management does not believe that the remaining provisions will have a material effect on the company’s consolidated financial position or results of operations when they become effective.

 

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During the three months ended March 31, 2007, an adjustment was made to shareholders’ equity related to the adoption of new accounting standards as previously disclosed; $66 million as a reduction of retained earnings in accordance with Financial Accounting Standards Board (FASB) Interpretation No. (FIN) 48 – Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 (see also Note 13).

 

Standards Issued But Not Yet Effective
In December 2007, the FASB issued SFAS No. 141(R) – Business Combinations. SFAS No. 141(R) expands the definition of a business, thus increasing the number of transactions that will qualify as business combinations. SFAS No. 141(R) requires the acquirer to recognize 100 percent of an acquired business’ assets and liabilities, including goodwill and certain contingent assets and liabilities, at their fair values at the acquisition date. Contingent consideration will be recognized at fair value on the acquisition date, with changes in fair value recognized in earnings until settled. Likewise, changes in acquired tax contingencies, including those existing at the date of adoption, will be recognized in earnings if outside the maximum allocation period (generally one year). Transaction-related expenses and restructuring costs will be expensed as incurred, and any adjustments to finalize the purchase accounting allocations, even within the allocation period, will be shown as revised in the future financial statements to reflect the adjustments as if they had been recorded on the acquisition date. Finally, a gain could result in the event of a bargain purchase (acquisition of a business below the fair market value of the assets and liabilities), or a gain or loss in the case of a change in the control of an existing investment. SFAS No. 141(R) will be applied prospectively to business combinations with acquisition dates on or after January 1, 2009. Adoption is not expected to materially impact the company’s consolidated financial position or results of operations directly when it becomes effective in 2009, as the only impact that the standard will have on recorded amounts at that time relates to disposition of uncertain tax positions related to prior acquisitions. Following the date of adoption of the standard, the resolution of such items at values that differ from recorded amounts will be adjusted through earnings, rather than through goodwill. Adoption of this statement is, however, expected to have a significant effect on how acquisition transactions subsequent to January 1, 2009 are reflected in the financial statements.

 

In December 2007, the FASB issued SFAS No. 160 – Noncontrolling Interests in Consolidated Financial Statements – an amendment of Accounting Research Bulletin (ARB) No. 51. SFAS No. 160 requires (1) presentation of ownership interests in consolidated subsidiaries held by parties other than the parent within equity in the consolidated statements of financial position, but separately from the parent’s equity; (2) separate presentation of the consolidated net income attributable to the parent and to the minority interest on the face of the consolidated statements of income; (3) accounting for changes in a parent’s ownership interest where the parent retains its controlling financial interest in its subsidiary as equity transactions; (4) initial measurement of the noncontrolling interest retained for any deconsolidated subsidiaries at fair value with recognition of any resulting gains or losses through earnings; and (5) additional disclosures that identify and distinguish between the interests of the parent and noncontrolling owners. SFAS No. 160 is effective for the company beginning January 1, 2009. Adoption of this statement is not expected to have a material impact on the company’s consolidated financial position or results of operations when it becomes effective in 2009, but may significantly affect the accounting for noncontrolling (or minority) interests from that date forward.

 

In December 2007, the Emerging Issues Task Force (EITF) issued EITF Issue No. 07-1 – Accounting for Collaborative Arrangements. EITF Issue No. 07-1 defines collaborative arrangements and establishes reporting and disclosure requirements for transactions between participants in a collaborative arrangement and between participants in the arrangement and third parties. EITF Issue No. 07-1 is effective for the company beginning January 1, 2009. Management is currently evaluating the effect that adoption of this issue will have on the company’s consolidated financial position or results of operations when it becomes effective in 2009.

 

Other new pronouncements issued but not effective until after March 31, 2008 are not expected to have a significant effect on the company’s consolidated financial position or results of operations.

 

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As of March 31, 2008, there were marketable equity securities of $65 million included in prepaid expenses and other current assets and $160 million of marketable debt and equity securities included in other long-term assets, all of which are recorded at fair value based upon quoted market prices. These investments can be liquidated without restriction. Other financial instruments recorded at fair value based on significant other observable inputs are not material. As of March 31, 2008, the company has no other assets or liabilities that are measured at fair value on a recurring basis.

 

 

Dividends on Common Stock – In April 2008, the company’s board of directors approved an increase to the quarterly common stock dividend from $.37 per share to $.40 per share, for shareholders of record as of June 2, 2008.

 

On February 21, 2007, the company’s board of directors approved a 23 percent increase to the quarterly common stock dividend, from $.30 per share to $.37 per share, effective with the first quarter 2007 dividend.

 

Conversion of Preferred Stock – On February 20, 2008, the company’s Board of Directors approved the redemption of the 3.5 million shares of mandatorily redeemable Series B convertible preferred stock on April 4, 2008. As of March 31, 2008, 3 million shares had been converted at the option of the holder into 5.5 million shares of common stock. Had the redemption of the remaining 0.5 million preferred shares taken place at March 31, 2008, each share would have been redeemed for 1.295 shares of common stock.

 

Subsequent to March 31, 2008, substantially all of the 0.5 million remaining preferred shares were converted at the option of the holder. All remaining shares were redeemed by the company. As a result of the redemption and conversion the company issued approximately 6.4 million shares of common stock.

 

 

Acquisitions
Essex – In January 2007, the company acquired Essex Corporation (Essex) for approximately $590 million in cash, including estimated transaction costs of $15 million, and the assumption of debt totaling $23 million. Essex provides signal processing services and products, and advanced optoelectronic imaging for U.S. government intelligence and defense customers. The operating results of Essex are reported in the Mission Systems segment. The assets, liabilities, and results of operations of Essex were not material to the company’s consolidated financial position or results of operations, and thus pro-forma information is not presented.

 

AMSEC – In July 2007, the company and Science Applications International Corporation (SAIC) reorganized their joint venture AMSEC, LLC (AMSEC), by dividing AMSEC along customer and product lines. Under the reorganization plan, the company retained the ship engineering, logistics and technical service businesses under the AMSEC name (the AMSEC Businesses) and, in exchange, SAIC received the aviation, combat systems and strike force integration services businesses from AMSEC (the Divested Businesses). Prior to the reorganization, including the three month period ending March 31, 2007, the company accounted for AMSEC, LLC under the equity method, whereas during the three months ended March 31, 2008, the results of operations of the AMSEC Businesses were consolidated.

 

Dispositions
Electro-Optical Systems – In March 2008, the company signed a definitive agreement to sell its Electro-Optical Systems business for $175 million in cash to L-3 Communications Corporation. The transaction closed in April 2008 and the company expects to recognize a small after-tax gain. Electro-Optical Systems, a part of the company’s Electronics segment, produces night vision and applied optics products and had sales and (loss) earnings after tax of approximately $190 million and ($8) million in fiscal year 2007 and $43 million and $1 million for the three months ended March 31, 2008, respectively. Operating results of this business are

 

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immaterial and reported as discontinued operations in the consolidated condensed statements of operations for all periods presented.

 

ITD – During the second quarter of 2007, management announced its decision to exit the remaining ITD business reported within the Electronics segment. Sales for this business for the three months ended March 31, 2007, were $4 million. The shut-down was completed during the third quarter of 2007 and costs associated with the shutdown were not material. The results of this business are reported as discontinued operations in the consolidated condensed statements of operations.

 

 

The company is aligned into seven segments categorized into four primary businesses. The Mission Systems, Information Technology, and Technical Services segments are presented as Information & Services. The Integrated Systems and Space Technology segments are presented as Aerospace. The Electronics and Shipbuilding segments are each presented as separate businesses.

 

In January 2008, the Newport News and Ship Systems businesses were realigned into a single segment called Northrop Grumman Shipbuilding to enable the company to more effectively utilize its shipbuilding assets and deploy its shipbuilders, processes, technologies, production facilities and planned capital investments to meet customer needs. This realignment had no impact on the company’s consolidated financial position, results of operations, cash flows, or segment reporting. Previously, these businesses were separate operating segments which were aggregated into a single segment for financial reporting purposes. In addition, certain Electronics businesses were transferred to Mission Systems effective January 2008. The transfer of these businesses did not have a material effect on the company’s consolidated financial position, results of operations, or cash flows.

 

In January 2007, certain programs and business areas were transferred between Information Technology, Mission Systems, Space Technology, and Technical Services.

 

The sales and segment operating income in the following tables have been revised, where applicable, to reflect the above realignments for all periods presented.

 

In January 2008, the company announced the transfer of certain programs and assets from the Mission Systems segment to the Space Technology segment, effective July 1, 2008. This transfer will allow Mission Systems to focus on the rapidly growing command, control, communications, computers, intelligence, surveillance, and reconnaissance business, and the missiles business will be an integrated element of the company’s Aerospace business growth strategy. This subsequent realignment is not reflected in any of the accompanying financial information.

 

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The following table presents segment sales and service revenues for the three months ended March 31, 2008 and 2007.

 

 

The following table presents segment operating income reconciled to total operating income for the three months ended March 31, 2008 and 2007.

 

 

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Shipbuilding Earnings Charge Relating to LHD-8 Contract Performance – LHD-8 is an amphibious assault ship under construction at one of the Gulf Coast shipyards. The LHD-8 contract features significant enhancements compared with earlier ships of the class and will incorporate major new systems, including a gas turbine engine propulsion system, a new electrical generation and distribution system, and a centralized machinery control system administered over a fiber optic network. The LHD-8 contract is a fixed-price incentive contract, and a substantial portion of the performance margin on the contract was previously consumed by the impact from Hurricane Katrina in 2005 and a charge of $55 million in the second quarter of 2007.

 

Lack of progress in LHD-8 on-board testing preparatory to sea trials prompted the company to undertake a comprehensive review of the program, including a detailed physical audit of the ship. From this review, management became aware in March 2008 of the need for substantial rework on the ship, primarily in electrical cable installations. As a result, management recorded a pre-tax charge of $272 million for the additional vessel labor, materials and level-of-effort support required to perform the rework and complete the ship. The charge directly impacted the company’s earnings and the contract is now in a forward loss position. The LHD-8 is now expected to be delivered in the second quarter of 2009.

 

As a result of the impact on workforce re-deployment caused by the delay in LHD-8, an evaluation was performed on other ships under construction at the Gulf Coast shipyards. Based on this evaluation, and a review of other program risk factors, management recorded a pre-tax charge of $35 million representing the cost and schedule impacts on these programs.

 

The company also evaluated the possible impairment of assets, including goodwill, caused by the delay in LHD-8. As a result, purchased intangibles with a net book value of $19 million associated with LHD-8 and other programs were written off. Management has put in place new leadership team assignments on the LHD-8 contract and will be applying known and proven quality control processes from the company’s other shipbuilding areas and elsewhere in the company to strengthen the quality assurance levels in the Gulf Coast shipbuilding operations. While management believes the charges above are adequate to cover known risk to date and that the steps taken to improve quality assurance will be effective, the LHD-8 program is on-going and the company’s efforts and the end results must be satisfactory to the customer. The company believes that its estimate of costs to complete the LHD-8 contract reflects appropriate cost estimates based on known information, but cannot provide absolute assurance that additional costs will not be required.

 

The aggregate effect of the foregoing is that a pre-tax charge of $326 million was recognized in the three months ended March 31, 2008.

 

Unallocated Expenses – Unallocated expenses include the portion of corporate expenses not considered allowable or allocable under applicable U.S. Government Cost Accounting Standards (CAS) regulations and the Federal Acquisition Regulation, and therefore not allocated to the segments, such as management and administration, legal, environmental, certain compensation and retiree benefits, and other expenses.

 

Net Pension Adjustment – The net pension adjustment reflects the difference between pension expense determined in accordance with accounting principles generally accepted in the United States of America and pension expense allocated to the operating segments determined in accordance with CAS.

 

Royalty Income Adjustment – Royalty income is included in segment operating income and reclassified to other income for financial reporting purposes.

 

 

Basic Earnings Per Share – Basic earnings per share from continuing operations are calculated by dividing earnings from continuing operations available to common shareholders by the weighted-average number of shares of common stock outstanding during each period.

 

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Diluted Earnings Per Share – Diluted earnings per share include the dilutive effect of stock options and other stock awards granted to employees under stock-based compensation plans, and the company’s mandatorily redeemable Series B convertible preferred stock. The dilutive effect of these securities totaled 10.5 million shares and 13 million shares (including 4.5 million shares and 6.4 million shares for the preferred stock, respectively) for the three months ended March 31, 2008 and 2007, respectively. The weighted-average diluted shares outstanding for the three months ended March 31, 2008 and 2007, exclude stock options to purchase approximately 1.3 million and 74,000 shares, respectively, because such options have an exercise price in excess of the average market price of the company’s common stock during the period.

 

Diluted earnings per share from continuing operations are calculated as follows:

 

 

Share Repurchases – The table below summarizes the company’s share repurchases beginning January 1, 2006:

 

 

As part of the share repurchase programs, the company entered into an accelerated share repurchase agreement in February 2007 with a bank to repurchase shares of common stock. The shares were immediately borrowed by the bank and then sold to and canceled by the company. Subsequently, shares were purchased in the open market by the bank to settle its share borrowings. Under this arrangement, the ultimate cost of the company’s share repurchases was subject to adjustment based on the actual cost of the shares subsequently purchased by the bank. If an additional amount was owed by the company upon settlement, the price adjustment could have been settled, at the company’s option, in cash or in shares of common stock. The final price adjustment under this agreement was immaterial.

 

Share repurchases take place at management’s discretion or under pre-established non-discretionary programs from time to time, depending on market conditions, in the open market, and in privately negotiated transactions.

 

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The company retires its common stock upon repurchase and has not made any purchases of common stock other than in connection with these publicly announced repurchase programs.

 

As of March 31, 2008, the company has $1.9 billion authorized for share repurchases.

 

 

Goodwill
The changes in the carrying amounts of goodwill for the three months ended March 31, 2008, were as follows:

 

 

Purchased Intangible Assets
The table below summarizes the company’s aggregate purchased intangible assets:

 

 

During the three months ended March 31, 2008, the company evaluated the possible impairment of assets, including goodwill, caused by the delay in the LHD-8 program (see Note 6). As a result, purchased intangibles with a net book value of $19 million were written off associated with the LHD-8 and other programs.

 

The company’s purchased intangible assets are subject to amortization and are being amortized on a straight-line basis over an aggregate weighted-average period of 21 years. Aggregate amortization expense for the three months ended March 31, 2008, was $53 million, including $19 million of additional amortization related to the write off above.

 

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The table below shows expected amortization for purchased intangibles for the remainder of 2008 and for the next five years:

 

 

 

U.S. Government Investigations and Claims – Departments and agencies of the U.S. Government have the authority to investigate various transactions and operations of the company, and the results of such investigations may lead to administrative, civil or criminal proceedings, the ultimate outcome of which could be fines, penalties, repayments or compensatory or treble damages. U.S. Government regulations provide that certain findings against a contractor may lead to suspension or debarment from future U.S. Government contracts or the loss of export privileges for a company or an operating division or subdivision. Suspension or debarment could have a material adverse effect on the company because of its reliance on government contracts.

 

As previously disclosed, in October 2005, the U.S. Department of Justice and a restricted U.S. Government customer apprised the company of potential substantial claims relating to certain microelectronic parts produced by the Space and Electronics Sector of former TRW Inc., now a component of the company. The relationship, if any, between the potential claims and a civil False Claims Act case that remains under seal in the U.S. District Court for the Central District of California remains unclear to the company. In the third quarter of 2006, the parties commenced settlement discussions. While the company continues to believe that it did not breach the contracts in question and that it acted appropriately in this matter, the company proposed to settle the claims and any associated matters and recognized a pre-tax charge of $112.5 million in the third quarter of 2006 to cover the cost of the settlement proposal and associated investigative costs. The company extended the offer in an effort to avoid litigation and in recognition of the value of the relationship with this customer. The U.S. Government has not accepted the settlement offer and has advised the company that if settlement is not reached it will pursue its claims through litigation. Because of the highly technical nature of the issues involved and their restricted status and because of the significant disagreement between the company and the U.S. Government as to the U.S. Government’s theories of liability and damages (including a material difference between the U.S. Government’s damage theories and the company’s offer), final resolution of this matter could take a considerable amount of time, particularly if litigation should ensue. If the U.S. Government were to pursue litigation and were to be ultimately successful on its theories of liability and damages, which could be trebled under the Federal False Claims Act, the effect upon the company’s consolidated financial position, results of operations, and cash flows would materially exceed the amount provided by the company. Based upon the information available to the company to date, the company believes that it has substantive defenses but can give no assurance that its views will prevail. Accordingly, the ultimate disposition of this matter cannot presently be determined.

 

As previously disclosed, on May 17, 2007, the U.S. Coast Guard issued a revocation of acceptance under the Deepwater Program for eight converted 123-foot patrol boats (the vessels) based on alleged “hull buckling and shaft alignment problems.” By letter dated June 5, 2007, the Coast Guard stated that the revocation of acceptance also was based on alleged “nonconforming topside equipment” on the vessels. On August 13, 2007, the company submitted a response to the Coast Guard, maintaining that the revocation of acceptance was improper. In late December 2007, the Coast Guard responded to the company’s August submittal and advised Integrated Coast

 

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Guard Systems (the contractors’ joint venture for performing the Deepwater Program) that the Coast Guard is seeking $96.1 million from the Joint Venture as a result of the revocation of acceptance of the eight vessels delivered under the 123-foot conversion program. The majority of the costs associated with the 123-foot conversion effort are associated with the alleged structural deficiencies of the vessels, which were converted under contracts with the company and a subcontractor to the company. The letter is not a contracting officer’s final decision and the company and its joint venture partner and subcontractor are preparing a response. Based upon the information available to the company to date, the company believes that it has substantive defenses but can give no assurance that its views will prevail.

 

Based upon the available information regarding matters that are subject to U.S. Government investigations, other than as set out above, the company believes, but can give no assurance, that the outcome of any such matters would not have a material adverse effect on its consolidated financial position, results of operations, or cash flows.

 

Litigation – Various claims and legal proceedings arise in the ordinary course of business and are pending against the company and its properties. Based upon the information available, the company believes that the resolution of any of these various claims and legal proceedings would not have a material adverse effect on its consolidated financial position, results of operations, or cash flows.

 

As previously disclosed, the U.S. District Court for the Central District of California consolidated two separately filed Employee Retirement Income Security Act (ERISA) lawsuits, which the plaintiffs seek to have certified as class actions, into the In Re Northrop Grumman Corporation ERISA Litigation. On August 7, 2007, the Court denied plaintiffs’ motion for class certification, and the plaintiffs appealed the Court’s decision on class certification to the U.S. Court of Appeals for the Ninth Circuit. On October 11, 2007, the Ninth Circuit granted appellate review, which delayed the commencement of trial previously scheduled to begin January 22, 2008. The company believes, but can give no assurance, that the outcome of these matters would not have a material adverse effect on its consolidated financial position, results of operations, or cash flows.

 

Insurance Recovery – As previously disclosed, the company is pursuing legal action against an insurance provider arising out of a disagreement concerning the coverage of certain losses related to Hurricane Katrina (see Note 10). The company commenced the action against Factory Mutual Insurance Company (FM Global) on November 4, 2005, which is now pending in the U.S. District Court for the Central District of California, Western Division. In August 2007, the district court issued an order finding that the excess insurance policy provided coverage for the company’s Katrina-related loss. In November 2007, FM Global filed a notice of appeal of the district court’s order. Based on the current status of the assessment and claim process, no assurances can be made as to the ultimate outcome of this matter.

 

 

Contract Performance Contingencies – Contract profit margins may include estimates of revenues not contractually agreed to between the customer and the company for matters such as incentives, contract changes, negotiated settlements, claims and requests for equitable adjustment for previously unanticipated contract costs. These estimates are based upon management’s best assessment of the underlying causal events and circumstances, and are included in determining contract profit margins to the extent of expected recovery based on contractual entitlements and the probability of successful negotiation with the customer. As of March 31, 2008, the amounts related to the aforementioned items are not material individually or in the aggregate.

 

In April 2007, the company was notified by the prime contractor on the Wedgetail contract under the Multirole Electronic Scanned Array (MESA) program that it anticipates the prime contractor’s delivery dates will be late and this could subject the prime contractor to liquidated damages from the customer. Should liquidated damages be assessed, the company would share in a proportionate amount of those damages to a maximum of approximately $40 million. As of March 31, 2008, the company has not been notified by the prime contractor as to any claim for liquidated damages. Until such time as additional information is available from the prime

 

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contractor, it is not possible to determine the impact to the consolidated financial statements, if any, for this matter.

 

Environmental Matters – In accordance with company policy on environmental remediation, the estimated cost to complete remediation has been accrued where it is probable that the company will incur such costs in the future to address environmental impacts at currently or formerly owned or leased operating facilities, or at sites where it has been named a Potentially Responsible Party (PRP) by the Environmental Protection Agency, or similarly designated by other environmental agencies. To assess the potential impact on the company’s consolidated financial statements, management estimates the total reasonably possible remediation costs that could be incurred by the company, taking into account currently available facts on each site as well as the current state of technology and prior experience in remediating contaminated sites. These estimates are reviewed periodically and adjusted to reflect changes in facts and technical and legal circumstances. Management estimates that as of March 31, 2008, the range of reasonably possible future costs for environmental remediation sites was $189 million to $275 million, of which $231 million is accrued in other current liabilities. Factors that could result in changes to the company’s estimates include: modification of planned remedial actions, increases or decreases in the estimated time required to remediate, discovery of more extensive contamination than anticipated, changes in laws and regulations affecting remediation requirements, and improvements in remediation technology. Should other PRPs not pay their allocable share of remediation costs, the company may have to incur costs in addition to those already estimated and accrued. Although management cannot predict whether new information gained as projects progress will materially affect the estimated liability accrued, management does not anticipate that future remediation expenditures will have a material adverse effect on the company’s consolidated financial position, results of operations, or cash flows.

 

Hurricane Katrina – In August 2005, the company’s operations in the Gulf Coast area of the U.S. were significantly impacted by Hurricane Katrina and the company’s shipyards in Louisiana and Mississippi sustained significant windstorm damage from the hurricane. As a result of the storm, the company has incurred costs to replace or repair destroyed or damaged assets, suffered losses under its contracts, and incurred substantial costs to clean up and recover its operations. As of the date of the storm, the company had a comprehensive insurance program that provided coverage for, among other things, property damage, business interruption impact on net profitability (referred to in this discussion generally as “lost profits”), and costs associated with clean-up and recovery.

 

The company’s Hurricane Katrina insurance claim is continually being evaluated based on actions to date and an assessment of remaining recovery scope. Certain amounts within the overall claim are still in the process of being finalized and the overall value of the claim may change from the amounts disclosed in the Notes to the Consolidated Financial Statements contained in the company’s 2007 Annual Report on Form 10-K. The company has recovered a certain portion of its claim and expects that its residual claim will be resolved separately with the two remaining insurers, including FM Global, and the company has pursued the resolution of its claim with that understanding (see Note 9).

 

The company has full entitlement to insurance recoveries related to lost profits; however, because of uncertainties concerning the ultimate determination of recoveries related to lost profits, in accordance with company policy no such amounts are recognized by the company until they are settled with the insurers. Furthermore, due to the uncertainties with respect to the company’s disagreement with FM Global, no receivables have been recognized by the company in the accompanying consolidated condensed financial statements for insurance recoveries from FM Global.

 

Co-Operative Agreements – In 2003, Shipbuilding executed agreements with the states of Mississippi and Louisiana whereby Shipbuilding leases facility improvements and equipment from Mississippi and from a non-profit economic development corporation in Louisiana in exchange for certain commitments by Shipbuilding to these states. As of March 31, 2008, Shipbuilding has fully met its obligations under the Mississippi agreement and has met all but one requirement under the Louisiana agreement related to minimum employment levels. Failure by

 

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Shipbuilding to meet the remaining Louisiana commitment would result in reimbursement by Shipbuilding to Louisiana in accordance with the agreement. As of March 31, 2008, Shipbuilding expects that the remaining commitment under the Louisiana agreement will be met based on its most recent business plan.

 

Financial Arrangements – In the ordinary course of business, the company utilizes standby letters of credit and guarantees issued by commercial banks and surety bonds issued by insurance companies principally to guarantee the performance on certain contracts and to support the company’s self-insured workers’ compensation plans. At March 31, 2008, there were $495 million of unused standby letters of credit, $149 million of bank guarantees, and $540 million of surety bonds outstanding.

 

The company has also guaranteed a $200 million loan made to Shipbuilding in connection with the Gulf Opportunity Zone Industrial Revenue Bonds issued in December 2006. Under the loan agreement the company guaranteed Shipbuilding’s repayment of the principal and interest to the Trustee and also guaranteed payment of the principal and interest by the Trustee to the underlying bondholders.

 

Indemnifications – The company has retained certain warranty, environmental, income tax, and other potential liabilities in connection with certain divestitures. The settlement of these liabilities is not expected to have a material effect on the company’s consolidated financial position, results of operations, or cash flows.

 

U.S. Government Claims – During the second quarter of 2006, the U.S. Government advised the company of claims and penalties concerning certain potential disallowed costs. The parties are engaged in discussions to enable the company to evaluate the merits of these claims as well as to assess the amounts being claimed. The company believes, but can give no assurance, that the outcome of any such matters would not have a material adverse effect on its consolidated financial position, results of operations, or cash flows.

 

Operating Leases – Rental expense for operating leases, excluding discontinued operations, for the three months ended March 31, 2008 and 2007 was $139 million and $130 million, respectively, net of immaterial amounts of sublease rental income.

 

Related Party Transactions – The company had no material related party transactions for any period presented.

 

 

The cost of the company’s pension plans and medical and life benefits plans is shown in the following table:

 

 

Employer Contributions – The company expects to contribute approximately $121 million to its pension plans and approximately $201 million to its medical and life benefit plans in 2008. As of March 31, 2008, contributions of

 

NORTHROP GRUMMAN CORPORATION

 

$26 million and $26 million have been made to the company’s pension plans and its medical and life benefit plans, respectively.

 

 

At March 31, 2008, Northrop Grumman had stock-based compensation awards outstanding under the following plans: the 2001 Long-Term Incentive Stock Plan, the 1993 Long-Term Incentive Stock Plan, both applicable to employees, and the 1993 Stock Plan for Non-Employee Directors and 1995 Stock Plan for Directors as amended. All of these plans were approved by the company’s shareholders. Share-based awards under the employee plans consist of stock option awards (Stock Options) and restricted stock awards (Stock Awards).

 

Compensation Expense – Total pre-tax stock-based compensation for the three months ended March 31, 2008 and 2007, was $44 million and $38 million, respectively, of which $4 million in each period was related to Stock Options and the remainder related to Stock Awards. Tax benefits recognized in the consolidated condensed statements of income for stock-based compensation during the three months ended March 31, 2008 and 2007, were $17 million and $15 million, respectively. In addition, the company realized tax benefits of $20 million and $30 million from the exercise of Stock Options and $94 million and $77 million from the issuance of Stock Awards in the three months ended March 31, 2008 and 2007, respectively.

 

Stock Options – The fair value of each of the company’s Stock Option awards is estimated on the date of grant using a Black-Scholes option-pricing model that uses the assumptions noted in the table below. The fair value of the company’s Stock Option awards is expensed on a straight-line basis over the vesting period of the options, which is generally four years. Expected volatility is based on an average of (1) historical volatility of the company’s stock and (2) implied volatility from traded options on the company’s stock. The risk-free rate for periods within the contractual life of the Stock Option award is based on the yield curve of a zero-coupon U.S. Treasury bond on the date the award is granted with a maturity equal to the expected term of the award. The company uses historical data to estimate forfeitures within its valuation model. The expected term of awards granted is derived from historical experience under the company’s stock-based compensation plans and represents the period of time that awards granted are expected to be outstanding.

 

The significant weighted average assumptions relating to the valuation of the company’s Stock Options for the three months ended March 31, 2008 and 2007, were as follows:

 

 

The weighted-average grant date fair value of Stock Options granted during each of the three months ended March 31, 2008 and 2007, was $15 per share.

 

NORTHROP GRUMMAN CORPORATION

 

Stock Option activity for the three months ended March 31, 2008, was as follows:

 

 

The total intrinsic value of options exercised during the three months ended March 31, 2008 and 2007, was $51 million and $77 million, respectively. Intrinsic value is measured using the fair market value at the date of exercise (for options exercised) or at March 31, 2008 (for outstanding options), less the applicable exercise price.

 

Stock Awards – Compensation expense for Stock Awards is measured at the grant date based on fair value and recognized over the vesting period. The fair value of Stock Awards is determined based on the closing market price of the company’s common stock on the grant date. For purposes of measuring compensation expense, the amount of shares ultimately expected to vest is estimated at each reporting date based on management’s expectations regarding the relevant performance criteria. In the table below, the share adjustment resulting from the final performance measure is considered granted in the period that the related grant is vested. During the three months ended March 31, 2008, 2.9 million shares of common stock were issued to employees in settlement of prior year stock awards that were fully vested, with a total value upon issuance of $233 million and a grant date fair value of $155 million. During the three months ended March 31, 2007, 2.6 million shares of common stock were issued to employees in settlement of prior year stock awards that were fully vested, with a total value upon issuance of $198 million and a grant date fair value of $124 million. There were 2.6 million Stock Awards granted in the three months ended March 31, 2007, with a weighted-average grant date fair value of $64 per share.

 

Stock Award activity for the three months ended March 31, 2008, was as follows:

 

 

Unrecognized Compensation Expense – At March 31, 2008, there was $312 million of unrecognized compensation expense related to unvested awards granted under the company’s stock-based compensation plans, of which

 

NORTHROP GRUMMAN CORPORATION

 

$31 million relates to Stock Options and $281 million relates to Stock Awards. These amounts are expected to be charged to expense over a weighted-average period of 1.8 years.

 

 

The company’s effective tax rates on income from continuing operations were 35.7 percent and 34.3 percent for the three months ended March 31, 2008 and 2007, respectively. As a result of the implementation of FIN 48, the company made a comprehensive review of its portfolio of uncertain tax positions in accordance with the recognition standards established by FIN 48. In this regard, an uncertain tax position represents the company’s expected treatment of a tax position taken in a filed tax return, or planned to be taken in a future tax return, that has not been reflected in measuring income tax expense for financial reporting purposes.

 

The company recognizes accrued interest and penalties related to uncertain tax positions in federal and foreign income tax expense. The company files income tax returns in the U.S. federal jurisdiction, and various state and foreign jurisdictions. The IRS is currently examining the company’s U.S. income tax returns for 1999-2006, including pre-acquisition activities of acquired companies. In addition, open tax years related to state and foreign jurisdictions remain subject to examination, but are not material.

 

Pursuant to the company’s merger with TRW in December 2002, the company is liable for tax deficiencies of TRW and its subsidiaries prior to the merger. The IRS examined the TRW income tax returns for the years ended 1999 through the date of the merger and asserted tax deficiencies for those years to which the company took exception. The 1999 through 2002 TRW audit deficiencies are currently under consideration at IRS Appeals. In January 2008 the company and the IRS reached a tentative agreement with respect to the proposed tax deficiencies. Although the final outcome is not determinable until the Joint Committee completes its review in 2008, it is reasonably possible that unrecognized tax benefits of up to $106 million may be eliminated, all of which would result in an offsetting reduction to goodwill.

 

NORTHROP GRUMMAN CORPORATION

 

 

To the Board of Directors and Shareholders of

Northrop Grumman Corporation

Los Angeles, California

 

We have reviewed the accompanying consolidated condensed statement of financial position of Northrop Grumman Corporation and subsidiaries as of March 31, 2008, and the related consolidated condensed statements of operations, comprehensive income, cash flows and changes in shareholders’ equity for the three-month periods ended March 31, 2008 and 2007. These interim financial statements are the responsibility of the Corporation’s management.

 

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

 

Based on our reviews, we are not aware of any material modifications that should be made to such consolidated condensed interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

 

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statement of financial position of Northrop Grumman Corporation and subsidiaries as of December 31, 2007, and the related consolidated statements of income, comprehensive income, cash flows, and changes in shareholders’ equity for the year then ended (not presented herein); and in our report dated February 20, 2008, we expressed an unqualified opinion on those consolidated financial statements and included an explanatory paragraph regarding the adoption of a new accounting standard for income taxes. In our opinion, the information set forth in the accompanying consolidated condensed statement of financial position as of December 31, 2007 is fairly stated, in all material respects, in relation to the consolidated statement of financial position from which it has been derived.

 

Los Angeles, California

April 24, 2008

 

NORTHROP GRUMMAN CORPORATION

 

 

The following discussion should be read along with the unaudited consolidated condensed financial statements included in this Form 10-Q, as well as the company’s 2007 Annual Report on Form 10-K filed with the Securities and Exchange Commission, which provides a more thorough discussion of the company’s products and services, industry outlook, and business trends. See discussion of consolidated results starting on page I-24 and discussion of results by segment starting on page I-26.

 

Northrop Grumman provides technologically advanced, innovative products, services, and solutions in information and services, aerospace, electronics, and shipbuilding. As a prime contractor, principal subcontractor, partner, or preferred supplier, Northrop Grumman participates in many high-priority defense and commercial technology programs in the United States (U.S.) and abroad. Northrop Grumman conducts most of its business with the U.S. Government, principally the Department of Defense. The company also conducts business with foreign governments and makes domestic and international commercial sales.

 

Business Outlook and Operational Trends – There have been no material changes to the company’s products and services, industry outlook, or business trends from those disclosed in the company’s 2007 Annual Report on Form 10-K. The company’s shipyard operations in the Gulf Coast continue to be impacted from workforce shortages resulting from hurricanes in 2005.

 

Notable Events – Notable events or activity during the three months ended March 31, 2008, affecting the company’s consolidated financial results included the following:

 

 

Use of Estimates – The company’s financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). The preparation of the financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingencies at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period. Estimates have been prepared on the basis of the most current and best available information. Actual results could differ materially from those estimates.

 

NORTHROP GRUMMAN CORPORATION

 

 

Selected financial highlights are presented in the table below.

 

 

Sales and Service Revenues

Sales and service revenues consist of the following:

 

 

Sales and service revenues for the three months ended March 31, 2008, increased $410 million, or 6 percent, as compared with the same period in 2007, reflecting higher sales in all operating segments except Technical Services. Sales and service revenues were impacted by a sales step back of $134 million on the LHD-8 program. See the Segment Operating Results section below for further information.

 

Cost of Sales and Service Revenues

Cost of sales and service revenues is comprised of the following:

 

 

Cost of Product Sales and Service Revenues – The increase in cost of product sales as a percentage of product sales for the three months ended March 31, 2008, as compared to the same period in 2007 is primarily due to a $326 million pre-tax charge at Shipbuilding for cost growth on the LHD-8 contract, related program risk and schedule impacts on other ships, and impairment of purchased intangibles at the Gulf Coast shipyard. Cost of service revenues as a percentage of service revenues for the three months ended March 31, 2008, as compared to

 

NORTHROP GRUMMAN CORPORATION

 

the same period in 2007, declined primarily at Technical Services, due to contract mix. See the Segment Operating Results section below for further information.

 

General and Administrative Expenses – In accordance with industry practice and the regulations that govern the cost accounting requirements for government contracts, most general corporate expenses incurred at both the segment and corporate locations are considered allowable and allocable costs on government contracts and such costs, for most components of the company, are allocated to contracts in progress on a systematic basis, and contract performance factors include this cost component as an element of cost. General and administrative expenses primarily relate to segment operations and remained essentially unchanged as a percentage of total sales and service revenues.

 

Operating Income

The company considers operating income to be an important measure for evaluating its operating performance and defines “operating income” as revenues less the related cost of producing the revenues and general and administrative expenses. Operating income for the company is further evaluated for each of the business segments in which the company operates, and “segment operating income” is one of the key metrics used by management of the company to internally manage its operations.

 

The table below reconciles segment operating income to total operating income:

 

 

Segment Operating Income – Segment operating income for the three months ended March 31, 2008, decreased $234 million, or 34 percent, as compared to the same period in 2007. Total segment operating income was 5.9 percent and 9.5 percent of total sales and service revenues for the three months ended March 31, 2008, and 2007, respectively. The decrease in operating income includes a $326 million pre-tax charge stemming from cost growth, schedule delays and impairment of purchased intangibles related to the Shipbuilding segment. See the Segment Operating Results section below and Note 6 to the Consolidated Condensed Financial Statements in Part I, Item 1 for further information.

 

Unallocated Expenses – Unallocated expenses include the portion of corporate expenses not considered allowable or allocable under applicable U.S. Government Cost Accounting Standards (CAS) regulations and the Federal Acquisition Regulation, and therefore not allocated to the segments, such as management and administration, legal, environmental, certain compensation and retiree benefits, and other expenses. Unallocated expenses for the three months ended March 31, 2008, was principally unchanged as compared with the same period in 2007.

 

Net Pension Adjustment – Net pension adjustment reflects the difference between pension expense determined in accordance with GAAP and pension expense allocated to the operating segments determined in accordance with U.S. Government Cost Accounting Standards (CAS). For the three months ended March 31, 2008, and 2007, pension expense determined in accordance with GAAP was $56 million and $87 million, respectively, and pension expense determined in accordance with CAS amounted to $115 million and $120 million, respectively. The reduction in GAAP pension expense is primarily due to a higher return on plan assets and a higher discount rate.

 

NORTHROP GRUMMAN CORPORATION

 

Royalty Income Adjustment – Royalty income is included in segment operating income and reclassified to other income for financial reporting purposes.

 

Interest Expense, Net

Interest expense, net for the three months ended March 31, 2008, decreased $12 million, as compared with the same period in 2007, primarily due to the conversion of the majority of the mandatorily redeemable preferred stock. See Note 4 to the Consolidated Condensed Financial Statements in Part I, Item 1.

 

Federal and Foreign Income Taxes

The company’s effective tax rate on earnings from continuing operations for the three months ended March 31, 2008, was 35.7 percent compared with 34.3 percent for the same period in 2007.

 

Discontinued Operations

Discontinued operations for the three months ended March 31, 2008 and 2007, represents the net operating results of the Electro-Optical Systems business formerly reported in the Electronics segment. See Note 5 to the Consolidated Condensed Financial Statements in Part I, Item I.

 

Diluted Earnings Per Share

Diluted earnings per share from continuing operations for the three months ended March 31, 2008, were $0.76 per share, as compared with $1.12 per share in the same period in 2007. Earnings per share are based on weighted average diluted shares outstanding of 349.3 million for the three months ended March 31, 2008, and 358.3 million for the same period in 2007. Diluted earnings per share from continuing operations and the weighted average diluted shares outstanding in 2008 include the dilutive effects of the mandatorily redeemable Series B convertible preferred stock. A substantial portion of the mandatorily redeemable Series B convertible preferred stock was converted to common stock in the first quarter of 2008, with the remainder converted or redeemed in April 2008. See Notes 4 and 7 to the Consolidated Condensed Financial Statements in Part I, Item 1.

 

Net Cash Provided by Operating Activities

For the three months ended March 31, 2008, net cash provided by operating activities was $194 million compared to $400 million for the same period in 2007. The decrease of $206 million, or 52 percent, was due to an increase in accounts receivable due to timing of billing and collection and as the result of the transition to an internal accounting software system common to other parts of the company.

 

SEGMENT OPERATING RESULTS

 

Basis of Presentation

In January 2008, the Newport News and Ship Systems businesses were realigned into a single segment called Northrop Grumman Shipbuilding to enable the company to more effectively utilize its shipbuilding assets and deploy its shipbuilders, processes, technologies, production facilities and planned capital investments to meet customer needs. This realignment had no impact on the company’s consolidated financial position, results of operations, cash flows, or segment reporting. Previously, these businesses were separate operating segments which were aggregated into a single segment for financial reporting purposes.

 

In addition, certain Electronics businesses were transferred to Mission Systems effective January 2008. The transfer of these businesses did not have a material effect on the company’s consolidated financial position, results of operations, or cash flows.

 

In January 2007, certain programs and business areas were transferred between Information Technology, Mission Systems, Space Technology, and Technical Services.

 

NORTHROP GRUMMAN CORPORATION

 

The sales and segment operating income in the following tables have been revised, where applicable, to reflect the above realignments for all periods presented.

 

In January 2008, the company announced the transfer of certain programs and assets from the Mission Systems segment to the Space Technology segment, effective July 1, 2008. This transfer will allow Mission Systems to focus on the rapidly growing command, control, communications, computers, intelligence, surveillance, and reconnaissance business, and the missiles business will be an integrated element of the company’s Aerospace business growth strategy. This subsequent realignment was not reflected in any of the accompanying financial information.

 

For presentation purposes, the company’s seven segments are categorized into four primary businesses. The Mission Systems, Information Technology and Technical Services segments are presented as Information & Services. The Integrated Systems and Space Technology segments are presented as Aerospace. The Electronics and Shipbuilding segments are presented as separate businesses.

 

 

NORTHROP GRUMMAN CORPORATION

 

Operating Performance Assessment and Reporting

The company manages and assesses the performance of its businesses based on its performance on individual contracts and programs obtained generally from government organizations using the financial measures referred to below, with consideration given to the company’s critical accounting policies and estimation process. Based on this approach and the nature of the company’s operations, the discussion of results of operations generally focuses around the company’s seven segments versus distinguishing between products and services. Product sales are predominantly generated in the Electronics, Integrated Systems, Space Technology and Shipbuilding segments, while the majority of the company’s service revenues are generated by the Information Technology, Mission Systems and Technical Services segments.

 

Sales and Service Revenues

Period-to-period sales reflect performance under new and ongoing contracts. Changes in sales and service revenues are typically expressed in terms of volume. Unless otherwise described, volume generally refers to increases (or decreases) in revenues incurred due to varying production activity levels, delivery rates, or service levels on individual contracts. Volume changes will typically carry a corresponding income change based on the margin rate for a particular contract.

 

Segment Operating Income

Segment operating income reflects the performance of segment contracts and programs. Excluded from this measure are certain costs not directly associated with contract performance, including the portion of corporate expenses such as management and administration, legal, environmental, certain compensation and other retiree benefits, and other expenses not considered allowable or allocable under applicable CAS regulations and the Federal Acquisition Regulation, and therefore not allocated to the segments. Changes in segment operating income are typically expressed in terms of volume, as discussed above, or performance. Performance refers to changes in contract margin rates. These changes typically relate to profit recognition associated with revisions to total costs estimated at completion (EAC) of the contract that reflect improved (or deteriorated) operating performance on a particular contract. Operating income changes are accounted for on a cumulative-to-date basis at the time an EAC change is recorded.

 

Operating income may also be affected by, among other things, the effects of workforce stoppages, the effects of natural disasters (such as hurricanes and earthquakes), resolution of disputed items with the customer, recovery of insurance proceeds, and other discrete events. At the completion of a long-term contract, any originally estimated costs not incurred or reserves not fully utilized (such as warranty reserves) could also impact contract earnings. Where such items have occurred, and the effects are material, a separate description is provided.

 

Contract Descriptions

For convenience, a brief description of certain programs discussed in this Form 10-Q is included in the “Glossary of Programs” beginning on page I-36.

 

INFORMATION & SERVICES

 

Business Descriptions

Mission Systems – A leading global system integrator of complex, mission-enabling systems for government, military, and commercial customers. Products and services are grouped into the following business areas: Command, Control and Communications (C3); Intelligence, Surveillance and Reconnaissance (ISR); and Missile Systems.

 

Information Technology – A premier provider of advanced information technology (IT) solutions, engineering, and business services for government and commercial customers. Products and services are grouped into the following business areas: Intelligence; Civilian Agencies; Commercial, State & Local (CS&L); and Defense.

 

Technical Services – A leading provider of logistics, infrastructure, and sustainment support, and also provides a wide-array of technical services including training and simulation. Services are grouped into the following

 

NORTHROP GRUMMAN CORPORATION

 

business areas: Systems Support (SSG); Life Cycle Optimization and Engineering (LCOE); and Training and Simulation.

 

 

Sales and Service Revenues

Mission Systems – Revenue for the three months ended March 31, 2008, increased $150 million, or 11 percent, as compared with the same period in 2007. The increase was primarily due to $67 million in higher sales in C3, $61 million in higher sales in ISR, and $31 million in higher sales in Missile Systems. The increase in C3 is due to higher volume in several programs, including Command Post Platform (CPP), Force XXI Battle Brigade and Below (FBCB2) Installation Kits (I-Kits), Counter-Rocket Artillery Mortar (CRAM), and Battlefield Airborne Communication Node (BACN), partially offset by lower deliveries and development activities in the F-22 and F-35 programs. The increase in ISR is primarily due to ramp-up in the Navstar Global Positioning System (GPS) Operational Control Segment (OCX) program and a restricted program awarded in 2007. The increase in Missile Systems is primarily due to increased activity resulting from higher customer funding in the Kinetic Energy Interceptors (KEI) program and higher subcontract and material costs on the Joint National Integration Center Research & Development (JRDC) program.

 

Information Technology – Information Technology revenue for the three months ended March 31, 2008, increased $47 million, or 5 percent, as compared with the same period in 2007. The increase was primarily due to $26 million in higher sales in CS&L, and $22 million in higher sales in Defense. The increase in CS&L is attributable to higher volume associated with the New York City Wireless program and the Virginia IT outsourcing program. The increase in Defense is due to higher volume associated with the Network Centric Solutions program.

 

Technical Services – Revenue for the three months ended March 31, 2008, decreased $15 million, or 3 percent, as compared with the same period in 2007. The decrease was primarily due to lower sales volume in SSG driven by the completion of the Western Range Operations program in 2007, and decreased customer spending on the Joint Base Operations Support (JBOSC) program.

 

Segment Operating Income

Mission Systems – Operating income at Mission Systems for the three months ended March 31, 2008, increased $28 million, or 24 percent, as compared with the same period in 2007. The increase is comprised of $13 million due to the higher sales volume described above, and $15 million due to the improvement in margin rate from 8.4 percent in the first quarter of 2007 to 9.4 percent in the 2008 quarter. Improvements in the FBCB2 Systems Engineering & Integration (SE&I), the National Team Ballistic Missile Command and Control (BMC2) and the CPP programs were the primary contributors to the rate improvement in the quarter.

 

Information Technology – Operating income at Information Technology for the three months ended March 31, 2008, increased $3 million, or 3 percent, as compared with the same period in 2007 primarily due to the higher sales volume described above.

 

Technical Services – Operating income at Technical Services for the three months ended March 31, 2008, decreased $2 million, or 7 percent, as compared with the same period in 2007 due to the reduced sales volume described above and contract mix.

 

NORTHROP GRUMMAN CORPORATION

 

AEROSPACE

 

Business Descriptions

Integrated Systems – A leader in the design, development, and production of airborne early warning, electronic warfare and surveillance, and battlefield management systems, as well as manned and unmanned tactical and strike systems. Products and services are grouped into the following business areas: Integrated Systems Western Region (ISWR); and Integrated Systems Eastern Region (ISER).

 

Space Technology – Develops and integrates a broad range of systems at the leading edge of space, defense, and electronics technology. The segment supplies products primarily to the U.S. Government that are critical to maintaining the nation’s security and leadership in science and technology. Space Technology’s business areas focus on the design, development, manufacture, and integration of satellite systems and subsystems, electronic and communications payloads, and high energy laser systems and subsystems. Products and services are grouped into the following business areas: Civil Systems; Military Systems; National Systems; and Technology & Emerging Systems (Technology).

 

 

Sales and Service Revenues

Integrated Systems – Revenue for the three months ended March 31, 2008, increased $59 million, or 5 percent, as compared with the same period in 2007. The increase was primarily due to $48 million in higher sales in ISWR and $13 million in higher sales in ISER. The increase in ISWR is due to higher volume associated with restricted programs, the Global Hawk High Altitude Long Endurance Systems (HALE) program, and the Unmanned Combat Air System Carrier Demonstration (UCAS-D) program, partially offset by lower volume in the F-35 and Multi-Platform Radar Technology Insertion Program (MP-RTIP) programs. The increase in ISER is due to higher volume associated with Air Mobility Tanker program, partially offset by lower volume in the E-10A program.

 

Space Technology – Revenue for the three months ended March 31, 2008, increased $21 million, or 3 percent, as compared with the same period in 2007. The increase was primarily due to $54 million in higher sales in National Systems and $16 million in higher sales in Civil Systems, partially offset by $61 million in lower sales in Military Systems. The increase in National Systems is due to higher volume associated with restricted programs. The increase in Civil Systems is primarily due to higher volume associated with the James Webb Space Telescope (JWST) program. The decrease in Military Systems is due to lower sales volume associated with the Advanced Extremely High Frequency (AEHF), Transformational Satellite Communications System (TSAT), and Space Tracking and Surveillance System (STSS) programs.

Integrated Systems – Operating income at Integrated Systems for the three months ended March 31, 2008, increased $10 million, or 6 percent, as compared with the same period in 2007. The increase is comprised of $7 million due to the higher sales volume described above, and $3 million due to the improvement in margin rate from 12.5 percent in the first quarter of 2007 to 12.7 percent in the 2008 quarter. Improvements in restricted programs, EA-18G, and the B-2 Stealth Bomber programs were the primary contributors to the rate improvement in the quarter.

 

NORTHROP GRUMMAN CORPORATION

 

Space Technology – Operating income at Space Technology for the three months ended March 31, 2008, increased $6 million, or 10 percent, as compared with the same period in 2007. The increase is comprised of $2 million due to the higher sales volume described above, and $4 million due to the improvement in margin rate from 7.8 percent in the first quarter of 2007 to 8.4 percent in the 2008 quarter. Improvements in the Airborne Laser (ABL) and restricted programs were the primary contributors to the rate improvement in the quarter.

 

ELECTRONICS

 

Business Description

Electronics is a leading designer, developer, manufacturer and integrator of a variety of advanced electronic and maritime systems for national security and select non-defense applications. Electronics provides systems to U.S. and international customers for such applications as airborne surveillance, aircraft fire control, precision targeting, electronic warfare, automatic test equipment, inertial navigation, integrated avionics, space sensing, intelligence processing, air traffic control, air and missile defense, homeland defense, communications, mail processing, biochemical detection, ship bridge control, and shipboard components. Products and services are grouped into the following business areas: Aerospace Systems; Government Systems; Naval & Marine Systems (NMS); Defensive Systems; Land Forces; Navigation Systems; Space Sensors & ISR Systems; and Defense Other.